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Should You Jump In Before a Fund Closes?

Not so fast, Fool. Great funds close for good reasons.

I'm feeling a bit giddy as I type. One of my Champion Funds newsletter picks will soon close to new investors. As someone whose job is to make forward-looking recommendations of funds that put the interests of their shareholders front and center, I can't help but feel a little bit of pride.

For starters, since I recommended this fine fund -- which, despite its focus on smaller-cap international stocks, also invests in the likes of Pfizer (NYSE:PFE) and American International Group (NYSE:AIG) -- the pick has made money for its shareholders. Among other things, I gave the fund the nod for three key reasons:

First, its management team has been on duty since the early '90s, plying a valuation-sensitive stock-picking strategy with both skill and consistency. Second, the fund's long-term performance has been outstanding. For the 10 years ended March 2005, the fund has surpassed the S&P and its typical peer -- all while shellacking the international MSCI EAFE index, too.

Last but not least: The team "eats its own cooking." That is, it invests its own money alongside its shareholders. When it comes to judging whether a fund's managers have your interests at heart, few details tell you more than that one.

For your eyes onlyThe fund's decision to "soft close" -- i.e., current shareholders will still be able to invest -- only underscores my sense of its commitment to shareholders. But because fund closings need to be considered carefully on a case-by-case basis, I'll update my Champion Funds subscribers later this week on how best to proceed with this one.

The closing, however, provides a choice opportunity to educate, amuse, and enrich the broader Fool community on why fund closings -- frustrating though they may be for prospective investors -- are almost always a good idea.

Here's why. A bloated asset base can make it difficult for a fund's managers to execute their strategy. This is particularly true of funds that specialize in smaller-cap names. Why so? Glad you asked.

First, small caps have rallied so far for so long that their valuations look quite rich relative to areas of the market that have been out of favor. Over the last five years, in fact, Morningstar reports that the typical "small-blend" fund has earned roughly 10% annualized. The typical "large-blend" fund, in the meantime, has shed about 2.7% of its value.

With that as a backdrop, it's not surprising that many high-quality small-cap funds have closed. Rather than letting cash pile up or putting new money to work in second-tier picks, many responsible fund shops would just as soon forgo the additional assets -- not to mention the additional fees those assets would generate -- for the sake of letting their managers do what they do best.

Good for them -- and their shareholders -- I say. But what's a savvy fund investor to do when she learns that a choice pick is going to close soon? That's an excellent question, and the answer is...

Haste makes wasteIt depends. Good funds close for good reasons, and whether or not you should get in before the door closes depends on a number of factors. Among them: the stated reason for the fund's close, the size of its asset base, and the area of the market in which the fund specializes.

Selling your shares, however, is an entirely different matter. In general, I think current shareholders in a fund that announces it's about to close should stand pat. After all, the fund company has made its closure decision with current shareholders in mind. So, unless there are unusual circumstances -- a management change, for example -- you might as well stay on board to reap the potential benefits that a closure may provide.

Indeed, for current shareholders there may be compelling reasons to continue sending new money to the fund.

But what about Magellan?To be sure, there are exceptions to these rules. I applauded Fidelity's decision to close its enormously popular Magellan(FUND:FMAGX) fund, which invests serious sums in such blue chips as General Electric(NYSE:GE) and ExxonMobil(NYSE:XOM).

Despite the closure, though, I think there are good reasons to consider selling this particular puppy. Even among large-cap behemoths, the fund has a massive asset base -- it recently weighed in with more than $57 billion -- and with all that moola in the pot, the fund has basically hitched a ride on the S&P.

Over the last three years, the fund's R-Squared score -- a gauge of how much of a fund's performance can be explained by movements in a given benchmark -- suggests that Magellan has simply become a pricey S&P 500 hugger. Why pay a premium for this fund when dirt-cheap S&P trackers such as Spiders(AMEX:SPY) and Fidelity Spartan 500 Index(FUND:FSMKX) can be had for just 0.11% and 0.10%, respectively?

The bottom lineAll fund investors -- and that would include more than 90 million of us at last count -- should pay close attention to, among other things, their funds' asset bases. Past performance grabs all the headlines, but along with expense ratios and managerial tenure, asset growth is a crucial number to keep an eye on, too.

That's precisely what we'll be doing over at Champion Funds. So if you own funds -- and you know you do, Fool -- I'd encourage you to sign up for a risk-free 30-day trial of the newsletter. Think of your trial as Mutual Funds 101, after which you can choose (or not) to hang around for more advanced studies -- not to mention the scintillating conversation that's happening on our dedicated discussion boards right now.

If most of the money you'll rely on for retirement is invested in funds (and my guess is that it is), you owe it to yourself to take our service for a spin.

Shannon Zimmerman won't mind one bit if you call him a fund geek.He doesn't own shares of any securities mentioned, but he is an investor in the soon-to-close Champ discussed above. The Fool has an open disclosure policy.